Have the feds put the right price on carbon?

An economic analysis suggests that the US government's estimate is way too low.

When the US government formulates a new environmental regulation, it typically performs a cost-benefit analysis of the expected impact of the changes. These calculations can be rather complex, as things like regulating pollution exact a cost on the polluters, but may save money for society as a whole. In 2007, a court ruled that the government needed to establish a price for carbon emissions (technically, the National Highway Transportation Traffic Safety Administration was ordered to do so when formulating new fuel efficiency standards). By 2009, the Obama administration had convened a multi-agency panel to come up with a standard value to be used by all federal agencies. The group produced a range of values, but came up with a central figure that it recommended all agencies use: $21 per metric ton of CO2.

A new, open access publication has now taken that estimate to task, with its authors complaining that the feds were far too simplistic about setting a price on carbon. Their analysis suggests that the cost of carbon should be at least twice that, and possibly over 12 times higher.

The study's two authors are based at the National Resource Defense Council and Cambridge University. And, even if you don't agree with their analysis, the study remains an interesting read because it does a good job of describing why putting a price on carbon is a real challenge. As expected, the results naturally depend strongly on the assumptions that you make, showing that small differences in assumptions could have a huge impact on policy.

The initial process of setting a price on carbon isn't very different from that of projecting climate change itself. Emissions scenarios (continued emissions, stabilization by 2050, etc.) get plugged into a climate model, which can project what the world will look like at various dates. The economic costs to humans, in terms of things like impacts on health, loss of infrastructure, changing agricultural zones, etc. can then be calculated using an economic model. All of these processes involve uncertainties, so the models are run thousands of times with slightly different values to get a range of uncertainties.

These models have a number of weaknesses. For example, they can't consider unforeseen technological innovations, such as an efficient means of carbon capture and storage. At the same time, there are things are already causing problems—ocean acidification being one of them—that aren't factored in at all. On the whole, the authors say, the process is widely viewed as underestimating the costs of current emissions.

In any case, this process can provide an estimate of the costs that can be avoided by preventing emissions now, putting a price on carbon. But then the fun starts: these costs are borne now, while the benefits will be received in the future. Adjusting for this requires calculating what's called a "discount rate," which reflects the fact that the money spent on controlling emissions could have been put to other uses, even if it's only earning interest.

This is where some of the simplicity of the US government analysis comes into play. Rather than trying to figure out what discount rate is likely, it simply picked a set of potential returns: 2.5, three, and five percent. It was the middle of these that put the $21/metric ton price on carbon.

One obvious problem with this that is pointed out by the new paper is that current rates of return appear higher than they should be because many externalities aren't priced into economic growth. But that's not the only problem with the government's approach—it also ignores other work in this field.

Economists have already developed a formula for calculating discount rates. It includes a factor that compensates for the fact that, as incomes grow over time, the savings experienced in the future will have less value, since they'll be a smaller fraction of the total income. But it also includes one that adjusts for the fact that most people will probably be willing to bear some costs now in order to keep from eliminating resources needed by future generations. As the authors note, the only reasons for ignoring this factor that's been proposed is "the unlikely possibility that the human race becomes extinct in the future (for a reason unrelated to climate change)."

Another complicating factor that's not considered by the government is that the impacts of climate change will frequently be most severe on the poor, both in terms of nations and individuals. Given that, even smaller costs will have an oversized impact on basic living conditions.

In general, the authors clearly feel that the middle-of-the-road three percent value used by the US government is too high, and largely based on the rate of return from risk-free bonds, rather than a careful analysis. They also point out that the EPA (which was involved in setting this value) had surveyed rates used by other organizations and countries, and found that three percent was the highest typically used (many values, in fact, were less than half that). Dropping to a rate of two percent would more than double the price of carbon (to $62/metric ton), while a value of 1.5 percent would raise it to $122. Using the more sophisticated method of calculating the discount rate could, depending on assumptions, produce a value over 12 times the $21 figure recommended by the US.

What are the consequences of these higher values? It would only take a price on carbon of $52/metric ton to make photovoltaic power economically competitive with coal, something that is only currently true for natural gas and wind (based on Department of Energy figures that don't include a price on carbon). If the cost went up to $74, then wind would be competitive with natural gas, too.

Clearly, this is a case where there is no one right answer, and even the best estimate will involve a number of assumptions. But the authors of the paper have made a compelling case that the US government could have been a lot more sophisticated in its analysis, and that small changes in the approach used could have a very large effect on policy.

Promoted Comments

2) Why call it "discount rate"? It already has a name: "opportunity cost."

They're two different concepts.

The 'discount rate' is how money loses value over time - a formalized way of expressing that a bird in the hand is worth two in the bush. If you stuff a $1 bill in your mattress, it will be worth a lot less in purchasing power 10 years from now - the ratio of what it's worth now compared to the future is the discount rate.

An 'opportunity cost' is the cost incurred by misallocating your money. If I blow $100 on hookers & beer, that's $100 I didn't spend on making the world a better place. The difference in value between the ideal use and the actual use is the 'opportunity cost'.

232 posts | registered Oct 24, 2011

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In the first paragraph you say CO2, but in the rest of the article you just say carbon. They are not the same thing (the price of carbon is 3.66 times as much). Comparing the price of a ton of C to a ton of CO2 is common source of confusion. I'm pretty sure you were actually talking in terms of CO2 the entire time, but you need to make that clear.

Another complicating factor that's not considered by the government is that the impacts of climate change will frequently be most severe on the poor, both in terms of nations and individuals.

Has anyone looked at the impact of cap and trade? The costs will be passed along to consumers, rich and poor alike.

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Given that, even smaller costs will have an oversized impact on basic living conditions.

Given that the idea behind cap and trade is to make energy expensive to reduce it's usage, seems to me that impacting living conditions is the whole idea behind cap and trade, seems rather silly to ignore that and look only at the hypothesized impacts of climate change (correct me if I'm wrong, but these are not 100% certain iron-clad predictions of the future).

And it seems to me that we need to have a replacement in place before phasing out traditional power, and as I understand it neither solar nor wind is suitable for baseline power.

In my experiences with cost benefit analyses (collegiate research into several Washington State analyses, such as the Alaskan Way Viaduct replacement tunnel), the majority of an analysis is either spent explaining why monetizing key aspects of the project is really, really hard, or spent ignoring most of why monetizing key aspect of the project is really hard. In this respect, cost benefit analysis is a very imperfect tool. The discerning analyst would be hard-pressed to deny that any finalized analysis has major caveats that could be reopened for debate (assuming an executive decision wasn't made to bypass debate in the first place).

With this in mind, it's not surprising that the emisisons analysis done by the US government comes under scrutiny. It just surprises me that the criticism is that the price of carbon is considered by third parties to be too low, rather than too high. I would have expected it to be the other way around.

With this in mind, it's not surprising that the [emissions] analysis done by the US government comes under scrutiny. It just surprises me that the criticism is that the price of carbon is considered by third parties to be too low, rather than too high. I would have expected it to be the other way around.

It depends on who you are talking to, naturally. Some would no doubt argue that we should be using 5%. Personally, I am not convinced we need to do anything to the price of CO2, we just need to tax the usage of things that lead to CO2 more. Gas - extra $1 per gallon. Coal - ignore the CO2 but require very clean emissions (no exceptions by the EPA please). That way we can take into account the short term costs of doing what we are doing (the long term costs of CO2 are extremely uncertain). This alone will encourage a vastly more efficient usage model. And if people don't like it they can vote the person that put something into practice out of office and change the rate. But must politicians lack the testicular virility to even propose such a concept.

Another complicating factor that's not considered by the government is that the impacts of climate change will frequently be most severe on the poor, both in terms of nations and individuals.

Has anyone looked at the impact of cap and trade? The costs will be passed along to consumers, rich and poor alike.

Except that the rich have the financial reserves to absorb the impact, and the poor do not. It is basic economic theory. It is less impactful to reduce your retirement savings rate than it is to slash $50 out of your grocery budget.

IMHO, the costs should not be passed down to customers partaking in low-income assistance plans. However, I doubt that the minority of businesses that know their customers' economic status is large enough to make this workable.

The only consequences are that other forms of power are suddenly competitive? I'm not trying to debate Global Warming or whatever, but that answer seems a bit too simple as well.

They become competitive because you've raised the cost of conventional power substantially, apparently out of concern that the poor will be affected by climate change but will be completely insensitive to substantially increasing the cost of living. Maybe it's just me, I don't get it.

Another complicating factor that's not considered by the government is that the impacts of climate change will frequently be most severe on the poor, both in terms of nations and individuals.

Has anyone looked at the impact of cap and trade? The costs will be passed along to consumers, rich and poor alike.

Except that the rich have the financial reserves to absorb the impact, and the poor do not.

The same applies to energy costs, does it not? If you're living on the margin and your energy costs double, what then?

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It is basic economic theory. It is less impactful to reduce your retirement savings rate than it is to slash $50 out of your grocery budget.

I'm not sure what you are saying, seems apples and oranges. Reducing your retirement will have an impact when you retire, but I suspect most of the poor at issue have no retirement. So when the decision is starve or freeze, which option does your economic analysis suggest?

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IMHO, the costs should not be passed down to customers partaking in low-income assistance plans. However, I doubt that the minority of businesses that know their customers' economic status is large enough to make this workable.

As I said, the carbon price (whatever it may be) will be passed down to all customers, rich and poor alike.

The only consequences are that other forms of power are suddenly competitive? I'm not trying to debate Global Warming or whatever, but that answer seems a bit too simple as well.

They become competitive because you've raised the cost of conventional power substantially, apparently out of concern that the poor will be affected by climate change but will be completely insensitive to substantially increasing the cost of living. Maybe it's just me, I don't get it.

I guess what I'd like to see is an estimate of how this would impact my electric bill. How much extra is the average American going to pay per month?

I have no idea what a metric ton of carbon is or what it looks like - I'm not going to be paying for it directly. Though if they do up prices, maybe I do want my bill to highlight how much extra I'm paying because of the cost of carbon.

Ah carbon credit. A wacky scheme dreamed up let companies pretend they aren't poisoning the planet. As usual, they quickly turned speculative vehicle for the greedy and corrupt.

"We pay a tribe in the Amazon to bottle their farts. This sequestered carbon totally offsets the methyl-mercury we dump into local waterways.", beams the CEO manically. "We pride ourselves on putting the environment ahead of profits."

I guess what I'd like to see is an estimate of how this would impact my electric bill. How much extra is the average American going to pay per month?

I have no idea what a metric ton of carbon is or what it looks like - I'm not going to be paying for it directly. Though if they do up prices, maybe I do want my bill to highlight how much extra I'm paying because of the cost of carbon.

How much your power bill goes up depends on how your energy is produced. If you live in California which has a high RPS (renewable portfolio standard) then it wont go up as much as a place that is mostly coal fueled.

IMO, we just need to stop arguing about the price and just put a carbon tax in place at $20/ton (I don't like the idea of cap & trade because it'll create a new commodity market for wall street fucksticks to start interfering with, just tax it and be done with it).

Ah carbon credit. A wacky scheme dreamed up let companies pretend they aren't poisoning the planet. As usual, they quickly turned speculative vehicle for the greedy and corrupt.

"We pay a tribe in the Amazon to bottle their farts. This sequestered carbon totally offsets the methyl-mercury we dump into local waterways.", beams the CEO manically. "We pride ourselves on putting the environment ahead of profits."

Yeah - not a fan myself. I would much prefer to see a direct tax on the things you don't like (as noted above).

Also not a fan of the articles' statement that a compelling case has been made. The fact of the matter is that any analysis (like the one the authors did) is based on such a large number of assumptions that it becomes essentially worthless (and no, increasing the number of times you try different scenarios doesn't make the results any better, it is still just a bunch of WAGing). Instead you are forced to take the practical approach and pick a number.

When you pick a number you need to understand the short term impact. Because of the potential for substantial short-term impact, you would want to error on the side of lowering the costs until the markets figure out efficient ways of factoring in and accounting for the increased costs. Having a 10 or 15 year plan for gradually increasing the costs makes sense because it provides predictability and doesn't create massive waves (or recessions). Suddenly making coal powered electricity more expensive than solar power would be unwise but making it clear than in 10-15 years it will be more expensive is much easier to work with. So, while I wouldn't recommend any kind of CO2 tax, it you are going to use one it should be applied slowly and gradually.

I guess what I'd like to see is an estimate of how this would impact my electric bill. How much extra is the average American going to pay per month?

I have no idea what a metric ton of carbon is or what it looks like - I'm not going to be paying for it directly. Though if they do up prices, maybe I do want my bill to highlight how much extra I'm paying because of the cost of carbon.

How much your power bill goes up depends on how your energy is produced. If you live in California which has a high RPS (renewable portfolio standard) then it wont go up as much as a place that is mostly coal fueled.

I'm not sure how true that is. Consider that 30% of California's power is imported, I have no idea whether that power is conventional or not, but I suspect most of it is not.

-- California produces roughly 70 percent of its electricity from power plants located within-- our state and from plants that are outside of the state but owned by California utilities.-- About 30 percent is imported electricity from the Pacific Northwest and the American -- Southwest.

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IMO, we just need to stop arguing about the price and just put a carbon tax in place at $20/ton (I don't like the idea of cap & trade because it'll create a new commodity market for wall street fucksticks to start interfering with, just tax it and be done with it).

You mean cap and trade is not a tax? I'll wait for the SC decision before I commit on that.

Clearly, this is a case where there is no one right answer, and even the best estimate will involve a number of assumptions.

Except for a failure to point out that assumptions are often egregiously wrong, and the longer-term the assumption, the larger the error tends to be, this would be the most accurate statement in the article.

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But the authors of the paper have made a compelling case that the US government could have been a lot more sophisticated in its analysis, and that small changes in the approach used could have a very large effect on policy.

The authors naively assume that the people in government crafting these policies have the same goals in mind that they do--which is their first mistake. It could be, for instance, that the sophistication employed by the government is intended to lessen the economic impacts of those policies. Unlike the authors of this paper, the government doesn't have the luxury of ignoring the present tense in order to speculate on the future. There appears to be little to no evidence that indicates the certainty of climate change that will result if the authors' suggestions were fully implemented--ie, aside from the very real possibility that they would be economically harmful, there's no proof anywhere that following the authors' suggestions would be in any way "beneficial" to the climate. Perhaps, though, the authors are not themselves sophisticated enough to understand this...

What are we going to do about people who refuse to pay the tax for the CO2 they exhale every day?They depend on society for the air they breathe and yet refuse to give something back.I say we ban untaxed breathing.

What are we going to do about people who refuse to pay the tax for the CO2 they exhale every day?They depend on society for the air they breathe and yet refuse to give something back.I say we ban untaxed breathing.

With this in mind, it's not surprising that the emisisons analysis done by the US government comes under scrutiny. It just surprises me that the criticism is that the price of carbon is considered by third parties to be too low, rather than too high. I would have expected it to be the other way around.

I think the article answers why it's so low, because then the renewable energies would actually be competitive, and we cant have that can we!

And if people don't like it they can vote the person that put something into practice out of office and change the rate.

The people setting the rate and creating regulations are not elected, they are administrative "experts" with minimal accountability for their decisions. I just don't see the benefits from this program in terms of improving the global climate will ever come close to justifying the immense impact it will have on middle and lower income people. The immense disparity in expert opinion as to the "true" cost of CO2 simply reinforces my fear. Historically, central planning and government price fixing, despite the best intentions and efforts, has an abysmal record of achieving the projected cost/benefit. And once in place, any regulatory system seeks first and foremost to perpetuate itself and expand, even at the expense of innovation and progress.

I don't think the market approach to controlling CO2 works, and I just see this as the government establishing a new tax revenue source which will likely fund other things and not controlling CO2 emissions.

This artifical trying to manipulate the market to make inefficient forms of power generation more competitive is doomed to fail because it doens't address the real problem of why they are uncompetitive. All that is going to happen is that the tax/fee will be passed down to consumers and the same dirty power plants will still be used.

It's absolutely absurd that money even factors into this issue. Mother nature isn't going to give us a pass on our survival because "it's too expensive" or "it's not profitable". You either play by her rules or you die. If we have a problem, and we do, we should be taking every measure we can to solve it regardless of money. I'm sure we'll be so glad we saved a few bucks when we all choke to death on our own complacent apathy. We should do it regardless because we have to.

Money is what puts food on your table and keeps the lights on. Go talk to people living in primitive conditions in the Third World and see if they agree with your assessment of money being irrelevant.

It just seems irrelevant to you because you've spent your life coddled by systems that just work without you bothering to understand their nature. Your power, heat and sustenance seem to magically appear when in truth they are the products of a complex system operated by money.

Of course, the article itself has the same sort of magical thinking underlying it. Studies such as mentioned in the article are generally only correct by accident because there is absolutely no incentive for the authors to let honesty outweigh their bias - the result was determined by policy preferences rather than outcome.

Even when the incentives make it likely that the modelers are aiming for a legitimate result rather than an act of salesmanship, such studies are incredibly difficult to conduct properly.

All the people talking about the impact of carbon pricing on low-income brackets seem to be ignoring that most realistic policy proposals include assistance plans or services that reduce or even wipe out the cost to these brackets. Subsidies for energy to the poor, reinvestment in local programs that ease the burden or improve efficiency, etc. etc. In the real world, a carbon pricing policy will not ignore the people who can barely afford power as it is.

You mean like on sulphur emissions in the 90's? The cap-and-trade that stopped acid rain from becoming worse? No discernable impact whatsoever on prices.

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The costs will be passed along to consumers, rich and poor alike

Yes, assuming there are added costs those can be then assumed to be passed on to the consumers and the producers, both, since economics works that way.

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Given that the idea behind cap and trade is to make energy expensive to reduce it's usage

The idea behind cap and trade is to make the existing costs be born by the people making the decisions to incur them, and if indeed that raises prices, then an obvious corollary is that other things will become cheaper in comparison so those higher prices won't even necessarily have to be paid. Another corollary is that if higher prices would be 'expensive', then the costs are already expensive and we'll definitely be paying those costs anyways if we don't act now.

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these are not 100% certain iron-clad predictions of the future

Like any kind of insurance, there are risks and probabilities. Like any kind of insurance, even something that's unlikely can be worth insuring against because of the risks involved.

IMO, we just need to stop arguing about the price and just put a carbon tax in place at $20/ton.

Nah. If carbon is really the end of the world as we know it, set it higher. $200-$500/ton, increasing by a percentage every year. Truly make carbon users pay for their emissions.

Tax the farms putting out methane at a higher rate, since it's a stronger greenhouse gas.

If the goal is to stop greenhouse gas emissions, no tax is too high. Sure, we'll end up back in the stone age... but after 90% of the planet dies off from starvation, our emissions will be back to pre-industrial levels.

Since nearly any attempt at establishing a cost of emitted carbon will be at least partially arbitrary, let's go there completely . . . treat emitted carbon as a sin, like alcohol or tobacco, and tax it as arbitrarily high as the market will allow without incurring criminal activity. I don't mean the fraud and scheming type, I mean the felonious type of cheating and avoiding. Start at $100/ton and if too many mobsters get in the business, drop it to $75. We cannot establish a truely accurate "cost" of emitted carbon, but we know it shouldn't be emitted, so set the tax at the maximum that will reduce emissions without a mob war.

In the real world, a carbon pricing policy will not ignore the people who can barely afford power as it is.

Of course they won't ignore the impact on low income households. The problem is that a fix for one problem always creates another. You can subsidize the poor with taxes from the rich, but it's not a dollar for dollar proposition. Only a fraction of the tax revenue will actually end up in the hands of those needing the subsidy, and meanwhile the full impact of the tax will disproportionately reduce supply (of all energy, not just traditional). With less supply, it will be the poor and the middle income level that are proportionately impacted most in terms of standard of living. That's just an example, there are always unseen consequences to market interference.

The only consequences are that other forms of power are suddenly competitive? I'm not trying to debate Global Warming or whatever, but that answer seems a bit too simple as well.

They become competitive because you've raised the cost of conventional power substantially, apparently out of concern that the poor will be affected by climate change but will be completely insensitive to substantially increasing the cost of living. Maybe it's just me, I don't get it.

Last I checked, one does not need money to survive, but a hospitable planet would be nice.

It's absolutely absurd that money even factors into this issue...we should be taking every measure we can to solve it regardless of money.

If you have a computer, phone, tv, house/apartment, car, etc., and buy your clothes and food instead of producing them yourself, then you don't really believe what you're saying. Money is a factor to everyone, some just admit it more readily than others.